There is a good chance that people make important life decisions based on their confidence in how the future will be. I know that I do.
This type of thinking may not get much attention in the media but it’s common among pretty much everybody, which means it’s human nature.
A good example is the fact that the environment of low (even negative) interest rates didn’t produce inflation the central banks were hoping for.
And it’s not that difficult to figure out why – whether you save for a house, for your child’s education or for the retirement – lower interest rates mean that you have to save more and spend less. How does this align with ambitious inflation targets?
People know that instinctively and don’t need a degree in economics to figure it out. Maybe the central bankers need a degree in psychology, or a dose of common sense. Not a law degree, which is so common in governments these days. Lawyers are trained to think that once they pass a legislation people must follow.
They tend to miss on the human nature thing. How many of us drive the speed limit on the highway, huh?
The change in comprehension of how the world works goes back to an important date in August 1971, when president Nixon took the dollar off the gold correlation, which was mandated since the end of the second world war. Dollar was backed by gold and the western currencies were tied to the dollar.
The situation was very serious at the time, and this being a vacation season, Nixon and his people were keenly observing if US dollars spent by tourists are still accepted in Europe.
They were, which thought everyone a valuable lesson – that confidence in currency is more important than gold backing of it.
And that confidence in currency really means the confidence in government that is behind it.
A new era began, only scarcely understood to this day.
The value of money is no longer based on anything tangible, it is based on the faith in the people who rule the country. And the might of the army, frankly.
You trust them, you spend. You don’t, then you hoard.
It’s always the feeling that takes precedence to knowledge, no? I don’t think it’s new, but fascinating still.
In the business world, it’s not the level of interest that drives investment decisions. If the cost of money is 10%, but I can make 20% off the project, I’ll go for it in a heartbeat. But if I can borrow at 2% and can hardly break even because of taxes, tariffs, unions and regulations, I’ll pass.
On that note, looking through history, the revolutions and uprisings of any kind seem to be always caused by excessive taxation. If we look at the business of war, it historically didn’t involve the population. People would be working in the fields, armies marching to battle and back, not really impacting anybody. It was about taxation – a king would look at the next country and figure how much he can make there in taxes before people revolt. Then he would calculate the cost of war, find a good general, and if the business case was strong, he would go for it. It’s no different in business world today. If a company is mismanaged and the stock price reflects it, it will be taken over by a competitor.
It was this observation that prompted de Tocqueville to state that war is caused by the weakness of a country.
So where is the confidence today?
There are three areas to consider in my view – one is big money, also called “smart”, as it would not be big otherwise, another is retail (individual investors), and then the government market interventions, which are huge, but there is not one person accountable at the end of the day.
The big money flows into US stock and bond market. Where else would you park a trillion dollars? Not is China, not in Europe (the biggest European bank, Deutsche Bank is flirting with a single digit stock price) not anywhere else. Only US markets are deep and liquid enough.
Retail participation is the stock market is low at present, people go into cash and hoard.
The governments, specially in Japan and the EU are basically the market makers when it comes to bonds (also corporate bonds). They have really destroyed the bond market with the huge buying spree. At present, there is not one good idea how to stop buying. Mr. Mario Draghi will leave his post in October 2019 and I’m sure it’s not soon enough for him.
Perhaps the conclusion is this: the confidence is backed by a government with the biggest army. How else US dollar would be the reserve currency of the world?
The USA will be the last to fold and is holding the world economy intact.
Think about it in that perspective next time you hear president Trump calling for increased defense spending.